Buyback, Dividend Bonanza Picks Up

U.S. companies continue to buy back stock and pay out dividends at a blistering pace, helping propel the stock market’s rally to record levels.

Stock buybacks among S&P 500 companies jumped to $128.2 billion in the third quarter, the highest level since the fourth quarter of 2007, according to S&P Dow Jones Indices. Buybacks rose 8.6% from a quarter ago and 24% from a year earlier.

Combined stock buybacks and cash dividends totaled $207 billion in the three months ended Sept. 30, which also marked the highest level since the fourth quarter of 2007. By comparison, the latest figure is almost three times the $71.8 billion total in the second quarter of 2009, when the economy was in the early stages of rebounding from the financial crisis.

Buybacks have a direct impact on companies’ share prices. They can boost earnings-per-share — a closely watched measure of profitability — by reducing shares outstanding, although some companies use the stock they buy to deliver shares to executives who exercise stock options.

But skeptics deride buybacks. They say the cash could be deployed in a more efficient manner; investing in research and development, boosting hiring or buying an existing company are three options. Companies also have a history of buying back shares at the wrong time. At the end of 2007, buyback activity was near record levels just as stocks were in the early stages of a precipitous drop.

Over the weekend, Bill Gross, who runs the world’s biggest bond fund at Pimco, tweeted about the impact of buybacks on the stock market.

Gross: Stocks have their own QE: “corp buybacks” at $500 billion a year. They are a main reason stocks go up. When do THEY taper?

Howard Silverblatt, senior index analyst at S&P, says buyback activity in the third quarter was even stronger than the headline figure shows, mainly because the quarter-ago comparison included Apple Inc.'s record-setting $16 billion buyback. Excluding Apple, buybacks jumped 21% from a quarter ago.

In returning money to shareholders, companies by and large are tapping into cash piles they have accumulated in the past few years by cutting costs or taking advantage of low interest rates to borrow funds. For the 12-month period ended in September, companies increased their buybacks by 15% to $445.3 billion. The high mark was reached in 2007, when companies spent $589.1 billion over the 12 month period.

“Just keeping up with the current bull market means that companies have to pay 25% more for the same number of shares they repurchased last year,” Mr. Silverblatt says. “However, we are starting to see excess buying, where the repurchases outnumber the issuance, and therefore reduce the share count. The lower share count leads to higher EPS, and the market likes higher EPS.”

Buybacks, just like margin debt, can be viewed either bullishly or bearishly. More buybacks suggest companies find their stocks undervalued, a sign of confidence in the economy and that the market will keep rising from current levels.

The chart below, courtesy of Mr. Silverblatt, represents buybacks in the S&P 500 as a percentage of total market value. Hard to derive “bubble” from this chart.

S&P Dow Jones Indices

Investors have also been rewarding companies that execute buybacks. Companies that heavily repurchase their own shares have seen their stock prices outperform the overall market over both short and long time frames.

The S&P 500 Buyback Index, which measures the 100 stocks with the highest buyback ratios, has surged 42% this year, compared with a 27% rally for the S&P 500. The buyback ratio accounts for the amount of cash paid for common shares over the past four quarters, divided by the market capitalization of the common stock.

A longer time frame shows an even greater disparity: The Buyback Index is up 26% on a five-year annualized basis, compared to an 18% gain for the S&P 500.